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Monday, October 26, 2015

How Tight is the US Labor Market?

The US unemployment rate was 5.1% in August and September. This rate is low by the standards of recent decades, but concerns remain over the extent to which is it not reflecting those who were long-term unemployed, have dropped out of looking for a job--and thus are no longer officially counted in the ranks of the unemployed.

Alan B. Krueger tackles this and related issues in "How Tight Is the Labor Market?", which was delivered as the 2015 Martin Feldstein Lecture at the National Bureau of Economic Research on July 22, 2015. An edited version of the talk is here; If you would like to watch the lecture and see the Powerpoint slides, you can do so here. (Full disclosure: Alan was Editor of the Journal of Economic Perspectives, and thus was my boss, from 1996-2002.) Short answer: The long-term unemployed dropping out of the labor market do contribute modestly to a lower labor force participation rate and the lower unemployment rate. However, if one focuses on short-run unemployment levels, the labor market is tight enough that it is leading to higher wages in much the same way as in previous decades.

Here are a few figures to set the stage. Here, I'll use versions generated by the ever-useful FRED website run by the Federal Reserve Bank of St. Louis, which has the advantage of updating the figures a bit from the ones provided in Krueger's talk last summer. For starters, the US unemployment rate has now dropped dramatically, back to levels that are relatively low in the context of recent decades.

However, if one focuses on the share of the unemployed who are long-term unemployed, defined as those without a job and still looking for one after at least 27 weeks, the picture isn't as rosy. Although the share of the unemployed who are long-term unemployed has declined, it still remains at relatively high levels by the standards of recent decades. To describe this pattern in another way, those who are long-term unemployed have found it harder to get back into employment than those who were unemployed for less than 27 weeks.

In addition, the official unemployment statistics only count someone as unemployed if they are out of a job and actively looking for work. This definition of unemployment makes some sense: for example, it would be silly to count a 75 year-old retiree or a married spouse staying home by choice as "unemployed." The labor force participation rate measures the share of adults who are "in the labor force," which means that they either have a job or are out of a job and looking for one. This rate has been generally declining since the late 1990s. There are a number of possible reasons for this decline: for example, the baby boomer generation is retiring in force, and more retirees means a lower labor force participation rate; more young adults are continuing to attend school into their 20s, and thus aren't counted as being in the labor force; and some of those who were long-term unemployed have given up looking for work, and are no longer counted in the unemployment statistics even though they would still prefer to be employed.

Krueger slices and dices this topic from several directions, but a lot of his recent work has focused on the issue of the long-term unemployed. Those who are long-term unemployed tend to become disconnected from the labor market over time. Their job search activity gradually diminishes, and employers are less likely to give interviews to those whose resumes show long-term unemployment. For illustration, here's a figure from Krueger on the probability of an unemployed worker finding a job based on how long the worker has been unemployed.

Krueger writes: "A variety of evidence points to the long-term unemployed being on the margins of the labor market, with many on the verge of withdrawing from searching for a job altogether. As a result, the long-term unemployed exert less downward pressure on wages than do the short-term unemployed. They are increasingly likely to transition out of the labor force, which is a loss of potential for our economy and, more importantly, a personal tragedy for millions of workers and their families." By Krueger's calculation, about half of the decline in the share of the long-term unemployed is due to that group dropping out of the labor force altogether. Of the decline in the labor force participation rate, most of it is due to a larger share of retirees in the population and young adults being more likely to remain in school, but on Krueger's estimates about one percentage point of the decline is due to long-term unemployment leaving the labor market and no longer looking for work. (I've discussed the decline in labor force participation rates a number of times on this blog before: for example, here, here and here, or for some international comparisons, see here.)

A different measure of the tightness of the labor market is to stop parsing the job statistics, and instead look at the patterns of unemployment and wages,what economists call a Phillips curve. In general, one might expect that higher unemployment would mean less pressure for wages to rise, and the reverse for lower unemployment. One sometime hears an argument that real wages haven't been rising recently in the way one should expect if unemployment is genuinely low (as opposed to just appearing low because workers have dropped out of the labor force).

Krueger argues that the patterns of wage changes and unemployment are roughly what one should expect. He focuses only on short-term employment (that is, employment less than 27 weeks), on the grounds that the long-term unemployed are more likely to be detached from the labor force and thus will exert less pressure on wages. Increases in real wages are measured with the Employment Cost Index data collected by the US Bureau of Labor Statistics, and then subtracting inflation as measured by the Personal Consumption Expenditures price index. In the figure below, the solid line shows the relationship between short-term unemployment and changes in real wages for the period from 1976-2008. (The dashed lines show the statistical confidence intervals on either side of this line.) The points labelled in blue are for the years since 2008. From 2009-2011, the points line up almost exactly on the relationship predicted from earlier data. For 2012-2014, the points are below the predicted relationship, although still comfortably within the range of past experience (as shown by the confidence intervals). For the first quarter of 2015, the point is above the historical prediction.

This pattern suggests that since 2008, the relationship between unemployment rates and wage increases hasn't changed much. To put it another way, the low unemployment rates now being observed are a meaningful statistic--not just covering up for workers exiting from the labor market--because they are tending to push up wages at pretty much the same way as they have in the past.